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Guest Commentary: Is Germany Willing to Accept More Inflation?

Guest Commentary: Is Germany Willing to Accept More Inflation?

2012-05-24 02:00:00
Yohay Elam, Forex Crunch,

An important metal workers' union in Germany signed a 13 month deal for a wage increase of 4.3%. This is a benchmark for other unions and also joins other agreements that surpass German inflation and the ECB's target.

This is certainly a "second round effect" which the ECB is afraid of, and so far avoided. Inflation in the euro-zone is mostly due to commodity prices. While Germans are afraid of inflation, some southern countries now fear a debt-deflation spiral which is devastating for these economies. Is Germany ready to pay higher inflation in order to see some growth in the troubled countries?

The southern German state of Baden-Wuerttemberg signed an agreement with 800,000 workers and this will likely be the benchmark for all of Germany's 3.6 million workers.

Also outside the manufacturing sector, significant wage increases have been agreed upon:

Ver.di, the country’s main labor union for non- manufacturing workers, won agreements in late March for a pay increase of as much as 6.3 percent over two years for state and municipal employees. Negotiations are also taking place in other industries.

Germany has an inflation rate of 2.2%, so these hikes exceed inflation and could push it higher. Germany is usually very wary of inflation, after the horrible hyperinflation experience during the Weimar Republic in the 1920s.

But the other opposite is also very dangerous: when prices fall, consumers postpone buying, pushing the economy further down, pushing unemployment higher, prices lower, etc. This is the threat upon the peripheral countries that suffer from austerity measures - austerity with deflation is the dreaded debt-deflation spiral.

These wage agreements could be a hint that Germany is willing to suffer higher inflation in order to keep the wheels moving in the southern economies. It is of high importance especially as the ECB currently keeps its interest rate at 1% and doesn't lower it, despite calls from the IMF and the OECD.

Higher German inflation could substitute a rate cut for the ECB and could weigh on the euro, adding to the debt crisis issues.

For more on EUR/USD see the Euro USD forecast.

By Yohay Elam, Forex Crunch

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